Real wages, real interest rates, and the Phillips curve

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This article argues that any analysis of a Phillips curve should include the real interest rate in addition to inflation and real wages as any changes in the interest rate changes the labour-capital input mix in the production process leading to a change in the level of employment in the economy. To justify this argument a Phillips curve model is developed, which includes the real interest rate in addition to inflation and real wages. After the diagnosis of the time series properties of the data, an error correction model is developed and estimated using a set of US annual data from 1948 to 1996. The estimated parameters of the model do suggest that one should really take into consideration of the real interest rate while analysing the Phillips curve. A non-nested test (F-test) also suggests that the Phillips curve model with real interest rate as an additional variable performs better than the conventional method that does not include the real interest rate. © 2005 Taylor & Francis Group Ltd.

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Applied Economics

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